Establishing Case Priorities and Enhancing the
Processes Would Improve the Employee Plans Efforts to Resolve Reported Funding
Deficiencies on Form 5500

September 2004

Reference Number:2004-10-192

This report has cleared the Treasury
Inspector General for Tax Administration disclosure review process and
information determined to be restricted from public release has been redacted
from this document.

September
30, 2004

MEMORANDUM FOR
COMMISSIONER, TAX EXEMPT AND GOVERNMENT ENTITIES DIVISION

This report presents the results of our review of funding
deficiencies reported on the Annual Return/Report of Employee Benefit Plan (Form
5500).The overall objective of this
review was to determine whether the Tax Exempt and Government Entities (TE/GE) Division
processes ensured the funding deficiencies reported by defined benefit and
defined contribution pension plans were appropriately resolved.The Employee Retirement Income Security Act
(ERISA) of 1974 establishes the minimum annual funding amounts that employers
must contribute to pension plans in an effort to ensure pension plans have
enough money to pay benefits when due.If the ERISA minimum funding requirements are not met, the underfunding
is reported on the Form 5500 return.

Pension underfunding has recently become a greater concern.For example, in 2002,
320 companies in the Standard & Poor’s (S&P) 500 Index had defined
benefit pension asset losses of $106 billion.However, pension asset levels are only one factor used in determining
whether pension plans are meeting the ERISA minimum funding requirements;
therefore, plan sponsors are generally not required to offset all pension asset
losses with corresponding contributions to the plans.In 2002, plan sponsors responded by making
contributions to their pension plans totaling $41 billion.

Under the ERISA, the
Department of Labor and the Department of the Treasury jointly have the
authority to issue regulations and ensure the ERISA is enforced.The Pension Benefit Guaranty Corporation
monitors the adequacy of pension plan funding to determine if a plan may need
to be terminated immediately.The TE/GE Division Employee
Plans (EP) function is tasked with enforcing the Department of the Treasury’s
ERISA requirements, which include monitoring compliance with minimum funding
requirements and assessing an excise tax on funding deficiencies.

The
EP function monitors minimum funding requirements by using a Funding Deficiency
Table, which is an inventory of all Form 5500 returns
that report a funding deficiency over a certain dollar amount.Classifiers in the EP function perform
research on the returns and attempt to contact plan sponsors to request an
explanation and/or resolution of the funding deficiency.Funding deficiencies that remain after the EP
classification research has been completed can be assigned to the EP
Examination function to determine whether an excise tax should be assessed.

In summary,
the EP
function is not sufficiently ensuring Form 5500 returns with reported funding
deficiencies are adequately resolved.Specifically, in October 2003, EP function management decided to close a
significant number of older cases without working them because of other priorities.Several factors were considered in deciding
to close these cases, but the primary reason was that, historically, a high
percentage of returns on the Funding Deficiency Table are actually in
compliance with minimum funding requirements; therefore, an examination would
not be necessary.We also determined
that EP function classifiers did not always take sufficient actions to resolve
funding deficiencies or entered inaccurate and/or incomplete closing actions on
the Funding Deficiency Table, so neither we nor EP function management could
determine whether appropriate actions had been taken to resolve the funding
deficiencies.

Regarding
the closure of cases, the Funding
Deficiency Table included 3,798 Form 5500 returns that were posted to the
Internal Revenue Service (IRS) Master File in either Fiscal Year (FY) 2002 or 2003.Of the 3,798 returns, 842 (22 percent) were closed without
being worked by the EP function.These
plans reported underfunding of approximately $672 million on the Forms 5500.

We also determined cases were not always worked in accordance with EP function procedures.One reason is that the Funding Deficiency
Table was not designed as an inventory management and control system and has
limitations for monitoring case assignments.We analyzed documentation for 1,650 Form 5500 returns that posted to the
IRS Master File in FY 2002 and determined EP function classifiers had performed
research to assess whether the plan sponsors resolved the potential
deficiencies for 1,082 of these returns.However, for 225 of the 1,082 returns, insufficient follow-up actions were taken
orcases were
closed without a determination as to whether the funding deficiency existed
and/or had been resolved.

In addition, our analysis of case actions
for the 1,047 returns on the Funding Deficiency Table that were worked by EP
function classifiers and posted to the Master File in FY 2002 found inaccurate
and/or incomplete information.For
example, 85 returns had incorrect closing codes recorded on the Funding
Deficiency Table, and 82 returns had actions recorded in the comment section that
were either unclear or did not fully address all the actions that should have
been taken.Also, 440 returns did not
have any information recorded in the comment section, which does not provide EP function management the
necessary information to verify the correct closing codes were used.

We
recommended the Director, EP, establish a process
for prioritizing returns on the Funding Deficiency Table based on risk factors
that will ensure returns with the greatest risk of insufficient funding for
future retirement benefits are worked first.In addition, we recommended the Director, EP Examination function,
perform the following: reemphasize the
procedures for working returns with reported funding deficiencies; expand the
classification funding procedures to include all the actions necessary to
resolve potential funding deficiencies; improve the Funding Deficiency Table by
creating closing codes to accommodate all closing actions; and establish a
periodic managerial review process of the Funding Deficiency Table to ensure
funding deficiency cases were adequately resolved and accurately recorded.

Management’s
Response:TE/GE Division Management agreed with the
findings and recommendations in the report.Specifically, TE/GE Division management will establish criteria for
prioritizing returns on the Funding Deficiency Table based on risk factors;
reemphasize procedures for working returns with reported funding deficiencies;
update the funding procedures manual to include action codes, no action code or
letter result code for bankruptcies and unable to locate taxpayers; and implement
a monitoring process of the funding deficiency program.TE/GE Division management stated they have
also revised the funding procedures manual to expand the closing codes to
better indicate the closing action recorded on the Funding Deficiency Table.In addition, the EP Classification function
will periodically review the Funding Deficiency Table comment section for all
cases closed due to taxpayer error and will work with a representative from the
EP Customer Education and Outreach function once error trends are identified.Management's complete response to the draft
report is included as Appendix V.

Copies
of this report are also being sent to the IRS managers affected by the report recommendations.Please contact me at (202) 622-6510 if you
have questions or Daniel R. Devlin, Assistant Inspector General for Audit
(Headquarters Operations and Exempt Organizations Programs), at (202) 622-8500.

Pension
plans provide millions of Americans the opportunity to acquire income for
retirement.The Employee Retirement
Income Security Act (ERISA) of 1974 establishes the basic requirements for
employee benefit plans.The sponsors of
pension plans and other fiduciaries have a responsibility to protect the interests
of the workers and retirees who are covered by the benefit plans. The plan trustee or trustees are responsible
for managing the assets in the pension plan to
provide for future retirements.Generally speaking, there are two types of plans:

·Defined Benefit Pension Plans – benefits paid to
participants at retirement are determined in advance by preestablished
formulas.These types of plans are
usually funded by employer contributions and have
remained particularly popular in specific industries.

·Defined Contribution Retirement
Plans – contributions to participants’ retirement plan accounts are determined
in advance.An example of this type of
plan would be a tax deferred savings account in which a plan participant
allocates a portion of his or her salaries or wages to investments within the
plan.In some instances, employers may
match all or a portion of the contribution.

Pension
plans invest assets in different vehicles, such as the stock market or mutual
funds, whose value may fluctuate depending on the volatility of the financial
and economic markets.The ERISA Section
302 or Internal Revenue Code (I.R.C.) Section 412 establish the minimum annual
funding amounts employers must contribute to plans in an effort to ensure plans
have enough money to pay benefits when due.The ERISA allows for plans to be underfunded except when the level of
the fund drops below the minimum annual funding level.Pension underfunding has recently become a
greater concern.An example of the
impact of fluctuating markets on the value of the pension plans occurred in
2002 when 320 companies in the Standard and Poor’s (S&P) 500 Index had
defined benefit pension asset losses of $106 billion. The Wilshire Associates study also reported
that, for these 320 companies, the pension surplus (the difference between the
market value of assets and liabilities) of $34 billion at the end of 2001
dropped to a deficit of $177 billion by the end of 2002.However, pension asset levels are only one
factor used in determining whether pension plans are meeting the ERISA minimum
funding requirements and, therefore, plan sponsors are generally not required
to offset all pension asset losses with corresponding contributions to the plans.In 2002, plan sponsors responded by
making contributions to their pension plans totaling $41 billion.

Minimum
funding requirements outlined in the I.R.C. and the ERISA are designed to
ensure pension plans have sufficient assets to pay benefits when those benefits
become due.However, these requirements
may not be sufficient for pension plans that may need to be terminated because
of sustained significant market drops.The
Pension Benefit Guaranty Corporation (PBGC) monitors the adequacy of pension plan
funding to determine if a plan may need to be terminated immediately.The Executive Director for the PBGC testified
before the House Committee on Ways and Means on April 30, 2003, stating that,
“With pension promises growing and plan funding levels at their lowest point in
more than a decade, the dollar amount of pension under funding has skyrocketed.”The Executive Director further testified that
the failure of several large companies with highly underfunded plans has caused
the PBGC’s insurance program for single employer plans to drop from a surplus
of $7.7 billion at the end of Fiscal Year (FY) 2001 to a deficit of $3.6 billion
by the end of FY 2002.The PBGC states
there was $300 billion in pension underfunding for FY 2002, although these
underfunded pension plans may have met the minimum funding requirements under the
ERISA.

If
the ERISA minimum funding requirements are not met, the underfunding is
reported on the Annual Return/Report of Employee Benefit Plan (Form 5500).In addition, the I.R.C. has established the
following requirements and penalties for plan sponsors who report a funding
deficiency on the Form 5500 and do not meet their minimum funding requirements:

·Excise tax can be assessed if the funding
requirement is not paid within 8½ months after the end of the plan year.For multi-employer plans, a 5 percent excise
tax may be assessed and for single employer plans, a 10 percent excise tax may
be assessed.

·An additional 100 percent excise tax can be
assessed if plan sponsors do not correct the funding deficiency within the tax
period in which the excise tax was assessed.

Under the ERISA, the Department of
Labor (DOL) and the Department of the Treasury jointly have the authority to
issue regulations and ensure the ERISA is enforced.The Presidential Reorganization Plan No. 4 of
1978 reduces the jurisdictional overlap of the ERISA by assigning the statutory
authority for the minimum standards to the Department of the Treasury, which
includes the employee plans funding requirements.The IRS Tax Exempt and Government Entities
Division Employee Plans (EP) function is the organization tasked with enforcing
the Department of the Treasury’s ERISA requirements, which include monitoring
compliance with minimum funding requirements and
assessing an excise tax on funding deficiencies.The IRS considers a pension plan to have a
funding deficiency if the level of the fund does not meet the ERISA minimum
funding requirement when the Form 5500 is filed.

The EP function established the
following process to monitor minimum funding requirements prescribed by the ERISA.A Funding Deficiency Table was created to
maintain an inventory of all Form 5500 returns that report a funding deficiency
over a certain dollar amount.The Form
5500 return information on the Return Inventory Classification System (RICS)is used
to update the Funding Deficiency Table.

Classifiers
in the EP function attempt to resolve the funding deficiencies by performing
research on the inventory of returns and by attempting to contact plan sponsors to request an
explanation and/or resolution of the funding deficiency.These resolutions can include:

·A return for which the
plan sponsor paid the funding deficiency after the return due date but before the
8½ month deadline in the I.R.C.This
type of payment is considered to be timely and is classified as a timing
difference.

·A return on which the
plan sponsor made an error in the preparation of the Form 5500, but the correct
amount would not reflect a funding deficiency.

·An excise tax return
filed reporting the correct amount of excise tax and the funding deficiency was
subsequently paid after the due date.

In addition, if this contact does
not sufficiently resolve the funding deficiency, the EP function classifier
can assign the return to the appropriate EP Examination function field group.If a plan sponsor does not agree to pay
excise taxes and minimum funding amounts, the EP
function refers the unagreed case to the DOL.

The audit was conducted in
accordance with Government Auditing Standards at the EP Planning and
Programs office located in Baltimore,
Maryland, during the period January
through June 2004.Detailed information on our audit
objective, scope, and methodology is presented in Appendix I.Major contributors to the report are listed
in Appendix II.

The EP function is not
sufficiently ensuring Form 5500 returns with reported funding deficiencies are
adequately resolved.Specifically, in October 2003, EP function
management decided to close a significant
number of older cases without working them because of other priorities.We also determined that EP function classifiers
did not always take sufficient actions to resolve funding deficiencies or entered
inaccurate and/or incomplete closing actions on the Funding Deficiency Table.As a result, EP function management cannot be
assured that plan sponsors are in compliance with the minimum funding
requirements outlined in the ERISA.

The Funding Deficiency Table
included 3,798 Form 5500 returns with reported funding deficiencies of over $2
billion for Forms 5500 that were posted to the IRS Master Filein
either FY 2002 or 2003.Of the 3,798 returns, 842 (22
percent) were closed without being worked by the EP function.These plans reported underfunding of
approximately $672 million on the Forms 5500.In addition, we identified 66 returns that posted to the Master File in
FY 2002 that were still open on the Funding Deficiency Table as of January 2004;
however, no work had been done to resolve the funding deficiency and there was
less than a year before the assessment statute expired.These reported funding deficiencies totaled
over $14 million.EP function management
advised us they were also considering closing these 66 returns without working
them.

Several factors were considered by
EP function management in deciding to close these cases:

·Historically, a high
percentage of Form 5500 returns on the Funding Deficiency Table are actually in
compliance with minimum funding requirements; therefore, an examination would
not be necessary.

·The RICS, which is
used to populate the Funding Deficiency Table, was shut down for 3 months to
convert to a new operating system.This
caused the EP Classification function to shift work priorities to meet the
preconversion and postconversion inventory needs.

·All RICS databases
were moved to a new computer server, which necessitated the development of new
procedures before EP function classifiers could use the new database.

As a
result, in October 2003, EP function management decided to realign its workload
by closing returns from old tax periods (any plans with a fiscal year ending
date before May 2001).The May 2001 date
was selected because timely filed returns would have at least 1 year remaining
on the Form 5500 return statute date.EP
function management believes at least 1 year remaining on the Form 5500 return statute
date is needed to perform an examination.However, a closer analysis of the 2,285 returns closed in October 2003
(for Form 5500 returns posting in FYs 1999 through 2003), showed the following:

·For 238 returns with
funding deficiencies totaling $91 million, there was still over 1 year remaining before the statute for the Form 5500 returns would expire (these were
late-filed Form 5500 returns).

·For 532 returns with
funding deficiencies totaling $537 million, there was less than 1 year
remaining before the statute for the Form 5500 returns would expire.

We found that the 238 returns had
been filed late, so the statute expiration date for the Form
5500 return would be calculated from the late-filing date, not from the due
date of the return. As a result, the EP
function may have
had more time to assess applicable
excise taxes. Using the tax
period as the primary criterion for closing older returns on the Funding
Deficiency Table may unnecessarily allow late-filed returns to be closed without being worked.

Funding
deficiencies in multiple years could be an indicator that funding problems are
persisting over extended periods and may increase the risk the plan will become
insolvent and/or need to be terminated.We looked for additional plans that reported funding deficiencies in
more than 1 year.Our analyses
identified several plans on the Funding Deficiency Table with Form 5500 returns
posting to the IRS Master File in more than 1 year during the period October 1,
1998, through September 30, 2003.For
example, of the 3,798 FYs 2002 and 2003 returns on the Funding Deficiency
Table, 349 plans that reported funding deficiencies in 1 of these 2 years also
had another reported funding deficiency during the period FYs 1999 through 2003.These 349 plans accounted for 755 returns
having a total reported funding deficiency of approximately $1.5 billion.

Although
EP function classifiers are advised to perform research to identify plans with
multiple funding deficiencies, EP function management does not have an
indicator for multiple years on the Funding Deficiency Table.Such an indicator would be helpful to EP
function management in prioritizing returns on the Table.

To make better use of
resources, EP function management should change its case assignment practices
to prioritize returns so EP function classifiers research
the highest risk cases.Prioritizing
cases based on key factors such as the amount of dollars or the number of
participants at risk, in addition to multiple years on the Funding Deficiency
Table, would better assist the EP function in identifying plan sponsors that
are at a higher risk of not being able to meet future retirement benefits.While it would be beneficial for all plan
sponsors to be notified of the need to be in compliance with minimum funding
requirements, the EP
function should ensure the plans with the highest risk are contacted.

Because the IRS has not devoted sufficient resources to ensure
all Form 5500 returns on the Funding Deficiency Table are resolved and has not
developed a system to prioritize returns on the Funding Deficiency Table, plan
sponsors with large funding deficiencies or with funding deficiencies in
multiple periods may not have any actions taken to resolve their funding
deficiencies.If funding deficiencies
are not resolved and are allowed to continue, pension plans may be left at risk
of not having sufficient assets to provide for future retirements.

1.The Director, EP,
should establish a process for prioritizing returns on the Funding Deficiency
Table based on risk factors that will ensure returns with the greatest risk of insufficient funding for future
retirement benefits are worked first.

Management’s Response:The Manager, EP Classification,
will be assigned the responsibility to establish criteria for prioritizing
returns on the Funding Deficiency Table based on risk factors (industry,
economic conditions, participant/assets, multiple years of funding
deficiencies) that will ensure returns with the greatest risk of insufficient
funding for future retirement benefits are worked first.

We identified several weaknesses in
how cases were researched and resolved on the Funding Deficiency Table and how
case actions were documented on the Table.Specifically, cases on the Table were not always worked in accordance
with EP function procedures, and the Funding Deficiency Table contained inaccurate
and/or incomplete information, so neither we nor EP function management could
determine whether appropriate actions had been taken to resolve the funding
deficiency.In addition, the Funding
Deficiency Table was not designed as an inventory management and control system
and has limitations for monitoring case assignments.

Returns with
potential funding deficiencies were not sufficiently worked

We analyzed the documentation on
the Funding Deficiency Table for 1,650 Form 5500 returns that posted to the IRS
Master File in FY 2002 and determined EP function classifiers had performed
research to assess whether the plan sponsor had resolved the potential
deficiencies for 1,082 of these returns.In reviewing the limited documentation available on the Funding
Deficiency Table for 225 of the research returns, we either determined the case
actions were insufficient or could not determine if the funding deficiencies
were appropriately resolved.These 225
returns included:

·Thirty-five returns for which insufficient follow-up actions were taken
on the compliance letters sent to plan sponsors.In these instances, it had been over 1 year
since the compliance letters had been sent, and, for 31 of the 35 cases, there
was no further action documented on the Funding Deficiency Table.EP function management was unaware that
follow-up actions had not been taken.As
a result, EP function management does not know if the funding deficiencies were
adequately resolved or if excise taxes were required to be filed and paid.

·Fifty-one returns for which cases were closed on the Funding
Deficiency Table involving specialized funding laws without a determination as
to whether the plan sponsors had complied with the appropriate funding
procedures.These returns involved
taxpayers from Puerto Rico, who have funding
rules which are unique and different from those for other plans.The EP function did not have procedures in place to instruct
classifiers to forward these cases to a group with specialized expertise on international
issues.

·Nine
returns referred by EP function classifiers to EP Examination function field
groups; however, the returns were closed by the EP Examination function field
groups without a validation as to whether the funding deficiency existed.If examination cases are closed without being
worked, the EP function procedures require the EP Examination function field group
to coordinate this action with the EP Classification function.The Manager, EP Classification, advised us
that these closing actions were not coordinated between the EP Examination
field group and EP Classification functions.

·One
hundred sixteen returns for which EP function classifiers determined an excise tax return was filed as a result of a funding
deficiency; however, no compliance letter had been sent to the plan sponsor to determine
whether the funding deficiency had been resolved.

·Fourteen
returns for which cases were closed without a determination as to whether the
plan sponsor had resolved the funding deficiency involving bankrupt or “unable
to locate” plan sponsors.EP function procedures
do not address the actions that need to be taken to resolve these types of
potential funding deficiencies and allow EP function classifiers
to determine the necessary actions.This
could result in inconsistencies in the amount of time and effort to resolve
these returns.

EP
function management recognized that Form 5500 returns on the Funding Deficiency
Table were not being adequately resolved; they are in the process of developing new guidelines for processing
these returns.One new process was
started in June 2004 and requires classifiers to provide a monthly tracking
chart to the Manager, EP Classification, which will assist the Manager in
monitoring activities and assessing the status of returns on the Funding
Deficiency Table.In addition, the Manager,
EP Classification, had previously clarified procedures in February 2004 by
instructing EP function classifiers to send a compliance letter requesting
verification that the funding deficiency was paid when the EP function classifier
determined that the plan sponsor had filed an excise tax return.Prior to this, some EP function classifiers were
closing these types of returns from the Table without attempting to verify whether
the funding deficiencies were paid.These procedures were brought to the EP function classifiers’ attention
during their monthly meetings.

Also, EP
function management advised us that an automated letter generation enhancement on the RICS was
piloted in October 2003.This enhancement
will streamline the process of developing correspondence by allowing EP function classifiers to draft letters by
inserting paragraphs previously prepared.In addition, an automated worksheet enhancement was being tested on the
Funding Deficiency Table.The automated
worksheet enhancement will allow EP function classifiers to readily review
pertinent Form 5500 information by systemically inserting RICS data into the
Funding Deficiency Table.EP function
management believes these actions will improve the efficiency and consistency
of case actions.

Further,
the Manager, EP Classification, advised us that limitations to information on the Funding Deficiency Table prevented
effective monitoring of classifiers’ activities.For example, the Funding Deficiency Table
does not indicate which cases are being worked until
the contact letter is sent to the plan sponsor.

The Funding Deficiency Table serves as the inventory management
and control system for funding deficiency cases in the EP Classification function,
but there are limitations for monitoring case assignments.Because of these shortcomings, EP function
management relies heavily on EP function classifiers
to accurately and completely record the status of case assignments and
the actions taken to resolve the funding deficiencies.

We determined the Funding Deficiency Table does not provide
sufficient information for all types of closures.Specifically, the Table does not have closing
codes or other identifiers for cases referred to the field for examination, requiring
special expertise (such as the cases from Puerto Rico),
or for which the classifier was unable to locate the plan sponsor.

As a result, the only way to
identify these types of cases using the Funding Deficiency Table is to review
the comment section.Another
option for identifying the cases referred to the EP Examination function field groups
is to run a special computer application comparing RICS data to information on
the Funding Deficiency Table.

However, our
analysis of case actions for the 1,047 returns on the Funding Deficiency Table
that were worked by classifiers and
posted to the Master File in FY 2002 found numerous examples of inaccurate and/or incomplete information.

·We identified 85
returns that had incorrect closing codes recorded on the Funding Deficiency
Table, based on a comparison of the closing code and the comment section.For example, some returns were closed with a
taxpayer error closing code, but the comment indicated the plan sponsor had
filed an excise tax return and had also made up the funding deficiency.

·We identified 82
returns for which actions recorded in the comment section were either unclear
compared to the letter results code that was entered by the EP function classifier
or the comment section did not fully address all the actions that should have
been taken to research the funding deficiency.For example, some returns were closed using the excise tax return
closing code but were silent on whether the funding deficiency was paid.

Also, we identified 440 returns with no information
recorded in the comment section.Without
this documentation, EP function management cannot determine if the cases
were properly worked and the correct closing codes used.

Although the Funding Deficiency Table has limitations as
stated above, it is the primary means to record case activity for funding
deficiency cases and management uses it to review case activity.As a result, it is important for EP function management
to emphasize documentation requirements to the EP classifiers.

In addition to providing management the ability to
adequately review case activity, another benefit from an accurate and complete
Funding Deficiency Table is the use by the EP Education and Outreach function to
assist plan sponsors in correctly preparing funding deficiency schedules on the
Form 5500.We analyzed the Funding Deficiency Table for the 745 returns that
posted to the Master File in FY 2002 and for which the case was closed after a
compliance letter was sent.For 487 (65
percent) of these cases, the EP function classifier learned the funding
deficiency did not exist after receiving a response to the compliance letter
that the plan sponsor had made an error in completing Form 5500.Additional education and outreach may reduce
the number of these errors, which would reduce the number of returns on the
Funding Deficiency Table.Further, EP function
classifiers did not adequately describe the error in the Funding Deficiency
Table for 399 of the 487 cases, which does not provide EP function management
with the information needed to determine whether education and outreach is
needed to prevent or reduce the errors.

Although EP function
management stated the Funding Deficiency Table was never meant to be an
inventory control system, it is considered the official record that
documents the EP function classifiers’ results
of working funding deficiency cases.For EP function management to effectively manage this program,
a management information system is needed which will enable management to
prioritize and manage workload, evaluate trends, and identify specific
education and outreach issues to benefit customers.If the Funding Deficiency Table is used for
this purpose, it should be enhanced to include closing codes for all types of
case closures and contain complete history information about case actions and
how the funding deficiency was resolved.This would provide EP function management with the necessary information
to ensure returns with reported funding deficiencies are appropriately
resolved.

2.Reemphasize the
following procedures for working a Form 5500 return with a reported funding
deficiency:

·Before a funding
deficiency case sent to an EP Examination function group is closed without an
examination, the field examiners in the EP Examination function should
coordinate this action with the EP Classification function.

·EP function classifiers
should use the correct closing code to indicate how the funding deficiency is
resolved.

·EP function classifiers
should document in the “comment” section of the Funding Deficiency Table the
reason for closing a return instead of sending it to the EP Examination function.

Management’s Response:The Director, EP Examination, will issue a field
directive to reemphasize the procedures for working returns with reported funding deficiencies.The EP Classification function is expanding the funding procedures
manual to better define the appropriate action code to be used when updating
the Funding Deficiency Table and to require documentation, as appropriate, in
the comment section when a return is not selected.

3.Expand the EP Classification
function funding procedures to include all the actions necessary to resolve
potential funding deficiencies including bankruptcies, unable to locate
taxpayers, and examinations requiring the special expertise of international
tax law.

Management’s Response:The EP Classification function will update the
funding procedures manual to include action codes, no action code or letter
result code, for bankruptcies and unable to locate taxpayers.Management will also include the research
steps classifiers will take for those cases.All international cases assigned will be noted in the comment section of
the Funding Deficiency Table.

4.Improve the Funding Deficiency Table by
creating closing codes to accommodate all closing actions including examination
referrals and unable to locate plan sponsors.

Management’s Response:The
EP Classification function has revised the funding procedures manual to expand
the closing codes to better indicate the closing action recorded on the Funding
Deficiency Table.

Management’s Response:The
EP Classification function is currently implementing a monitoring process for
the deficiency program.A schedule will
be developed to perform workload reviews to ensure funding deficiency cases are
adequately resolved and accurately recorded.

6.Periodically review the funding deficiency cases that
are closed because of a taxpayer error to determine whether any of the errors
could be reduced or eliminated through additional education and outreach.

Management’s Response:The EP
Classification function will periodically review
the comment section for all cases closed due to taxpayer error and will
work with a representative from the EP Customer Education and Outreach function
once error trends are identified.

The objective of this audit was to determine whether the processes the Tax Exempt and Government Entities Division uses
ensure the funding deficiencies reported by defined benefit and defined
contribution pension plans were appropriately resolved.To accomplish our objective, we:

A.Interviewed EP Examination function
personnel and reviewed supporting documentation to determine the process the EP
function uses to ensure the Return Inventory Classification System (RICS)
under the Funding Deficiency Table contains all of the defined benefit and
contribution plans with a reported funding deficiency.

B.Interviewed EP function management and obtained
documentation of procedures to determine the process the EP function uses to
ensure all returns with reported funding deficiencies are resolved.

C.Obtained a download of the 5,860 funding
deficiencies that posted to the Internal Revenue Service (IRS) Master File during Fiscal Years 1999 through 2003 and categorized the records
by 1) closed by compliance letter, 2) closed by examination, 3) closed without
an examination or compliance letter, or 4) open/unresolved to determine whether
the EP function appropriately resolved the funding deficiencies.

II.Evaluated the results
of compliance letter closures to determine whether process improvements can be
identified to reduce the number of cases with taxpayer and/or IRS errors.

A.Determined whether the
EP function has a process to evaluate the funding deficiencies resulting from
errors and to either correct the IRS process or educate the plan sponsors to
prevent the errors in the future.

This appendix presents detailed
information on the measurable impact that our recommended corrective actions
will have on tax administration.This
benefit will be incorporated into our Semiannual Report to the Congress.

The Employee Plans (EP) function
established a Funding Deficiency Table to maintain an inventory of all Annual
Return/Report of Employee Benefit Plan (Form 5500) returns that report a
funding deficiency over a certain dollar amount.Classifiers in the EP function attempt to resolve the funding
deficiencies by performing research on the inventory of returns and by
attempting to contact plan sponsors
to request an explanation and/or resolution of the funding deficiency.The
Funding Deficiency Table serves as the inventory management and control system
for funding deficiency cases in the EP Classification function.

Our analysis of case actions for 1,047 returns on the
Funding Deficiency Table that posted to the Master Filein Fiscal Year 2002 and were worked by EP function classifiers found
167 returns with inaccurate and/or incomplete information.These included 85 returns with incorrect
closing codes and 82 returns for which actions recorded in the comment section
were unclear. An accurate and complete
Funding Deficiency Table will provide management the ability to adequately
review case activity.It will also
enable the EP Education and Outreach function to assist plan sponsors in
correctly preparing funding deficiency schedules on the Form 5500.